Prepare to trade commodities and learn to trade – Part 2

This is a transcript for the second part of the series on trading commodities, which I recorded in March, about a turn in the commodities cycle.

If you would prefer to listen to the podcast click here, otherwise read below.

You can also listen to all previous podcasts here.

Commodities have been down, however, does this mean that we should wipe commodity related stocks from our watch lists completely? Based on history, this wouldn’t be wise.

In part 1 of this series on commodities, I discussed my view on the iron ore price, as well as important price levels for some of the big iron ore miners.

In this podcast, my aim is to get you thinking about preparing your watch list for a change in commodity prices and to inspire you to learn to trade. The market is fascinating, you will be amazed at what you can learn.

History shows how there will come a time, after a major decline, when stocks must return to growth. Of course there may be some companies that don’t recover. Falling share prices, high production costs and high levels of debt are a recipe for disaster, and this sort of information is available to you on your broker’s website and in company reports.

I strongly suggest that you carefully consider your risks when selecting stocks that have been trading in a long term decline, where the share price has been falling, and making lower lows over at least 18 months. Inexperienced traders often try to pick stocks when they are still falling, and you need the know-how so that you can trade and do so at the most favourable time and with little risk to your overall trading capital.

If you are a trader, or you would like to learn to trade, now is a really good time to prepare for future growth opportunities in areas that have been in decline.

People trade for different reasons, some to grow their capital base, others trade for cash flow or income, and commodities stocks can be part of either plan. If you would like to listen to a podcast about trading for cash flow click here.

However, many don’t have a plan to trade well, or haven’t really thought enough about why they want to trade. Unfortunately, most learn to trade at the school of hard knocks instead of getting a quality education.

Yesterday’s out of favour companies may turn into tomorrow’s windfall. However, the inexperienced, or uneducated traders, without a proper plan for the market, or without structure to their trading approach, will tend to try to chase what has already run based on news, and this is why we see so many jump in near market tops, and then out near market bottoms. The idea is to learn to trade, learn to read the charts, and plan your trades, rather than being reactive to the market.

If you have been watching commodities, and the related market sectors and stocks, you will have seen so many companies, whose fortunes are tied to commodities prices, take a significant dive in value. Some stocks are trading at, or are still falling towards all-time lows.

Reports indicate that earnings for the resources sector overall are down by around 20% and will continue to fall. However, it is the stock price chart that is likely to tell you in advance when the fall is over.

If you haven’t put together a process to select stocks for your watch list, or you haven’t learnt how to even create one then you are missing a very important part of what you need to run your portfolio well. There is no better time to learn than now. It’s the year of the sheep, or the ram, and according to around 1.5 trillion people in China this year is likely to be special and favours prosperity.

So to get you thinking about what your next steps need to be to create your watch list and select the best stocks, I have outlined three different approaches:

1)    Lead with fundamentals – decide on a set of company fundamentals, and use them to filter stocks for your watch list. To do this, place your attention on company earnings, in particular the forecasts, as we like to see good earnings growth, preferably double digits.

Then decide on the buy and sell rules that are likely to have a high probability of generating a profit and wait for the rules to trigger before you enter. If you have a really good set of rules that you have tested on your stocks, this reduces your risk of loss which could come about if there is a change in earnings.

2)    Top down approach, with market sectors – Look at the market sector charts and select sectors that are looking strong, or may be about to confirm support for a rise. You need to know how to analyse a price chart, big picture. Most traders without a formal education struggle with this approach. Look at the charts for the Energy and Materials sectors, as well as a Resources index.

There is no short cut to doing this well. You then select the best stocks within the sectors chosen and can either make the final selection based on company fundamentals, or your analysis on the stock’s price chart. As with point 1, you determine your trading rules that have a high probability of a profitable result.

3)    Simply look at the top 50 companies and choose stocks that, based on technical analysis, appear to be close to a turn, or are trading in a strong trend with sufficient upside for a trade. Again you determine your rules.

One of the easiest and cheapest ways to get started in the share market and learn to trade is by joining our Your Trading Mentor course. This will give you the ability to determine a set of trading rules to help you profit and keep you safe in the market.

For those wanting to leap ahead quickly, accelerate your learning, and to be able to analyse the big picture to pick the best stocks for your watch list, and to determine the best rules to trade, we have the Diploma of Share Trading and Investment, which you can read about on our website at the Wealth Within Institute. This second option is your best choice if you really want to maximise opportunities when the commodities cycle turns.

It is really important that you pick stocks for your watch list across different areas of the market. For a more balanced approach. I suggest that you might have a maximum of 20 stocks on your watch list and five could be resources type stocks.

A few years ago, a young guy came to study with us. As part of the Diploma of Share Trading and Investment we provide you with six months access to trading support for free. He admitted in an email that he had a string of losses. So I asked him to email me his watch list. The list was almost entirely focussed on commodities related stocks.

All the while, if he had looked at what the bigger picture analysis was showing him he would have recognised that most of the stocks were falling. Problem was that he was still trying to catch the stocks as they fell, or trying to guess the turn so that he could get the maximum profit. But the stocks kept falling, and he kept losing. He had ignored what he learnt about the bigger picture analysis because he wanted to be right, and he was chasing losses.

He was only looking very short term, as this is how he had always traded before coming to us. Old habits sometimes die hard. The rest of the market was rising, and he could have made money there but he was so fixated on trying to be right and trying to make up what he had lost. He said that it took a few big hits to his bank account before he realised that he had to ask for help.

From time to time, most traders need someone that they can talk to or bounce ideas off, even if the trades are going well, or just to get a different perspective. Remember that there will be times when looking through our own eyes you miss what is right there.

So, I suggest that you always have a balanced watch list, however, when one sector is turning or has been rising strongly, you are likely to put more focus there. If another area of the market changes you can adjust your focus accordingly, and you will still have your finger on that pulse.

How you ultimately select your five resources related stocks will depend on the criteria you set, and the Diploma of Share Trading and Investment, and trading support will get you onto the right path to do this.

By the way, if you like particular podcasts, you are more than welcome to let us know by simply leaving a 5 star rating and a positive review in iTunes. This will assist us to work out what you want to hear more about in future.

My next podcast will conclude the series with a discussion on the oil price.

If you are seeking information about how you can learn to trade the share market, feel free to send an email to info@wealthwithin.com.au.